Get the US Dollar Right

Client Talking Points

US Dollar Action

As we say often at Hedgeye, if you get the US dollar right, you get a lot of other things right. However, you still have to understand how the dollar is correlated to different assets, and those correlations change over time. Right now, an up US dollar means US and Asian stocks are higher but Brazilian, Russian and Emerging Market stocks are down. Also, right now, a lower US dollar means higher commodities and basic materials stocks.

Crisis in the Crisis?

Cyprus wasn’t really a crisis though many would want you to believe it was a major global contagion. There are, though, economies in Europe that are struggling, and fear is indeed alive and well across the continent there. The Euro is in a bearish formation, and Italy has been bearish on TRADE and TREND durations for a month now.

Asset Allocation

CASH

30%

US EQUITIES

20%

INTL EQUITIES

20%

COMMODITIES

0%

FIXED INCOME

6%

INTL CURRENCIES

24%

Top Long Ideas

Company

Ticker

Sector

Duration

DRI

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. Darden reported earnings today that beat Wall Street expectations, though net income declined 18%.

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

“Our cross country tour of the most hated bull market move in modern history carries on.” --@KeithMcCullough

QUOTE OF THE DAY

“If you tell the truth, you don’t have to remember anything.” – Mark Twain

STAT OF THE DAY

357,000, the number of initial jobless claims reported this morning, which was higher than expectations of 340,000

03/28/13 08:01 AM EDT

Ears Up

This note was originally published
at 8am on March 14, 2013 for Hedgeye subscribers.

“You can judge by his eyes and ears. One cannot read bears like that.”

-John Vaillant, The Tiger

Is this a bull or a bear? Whatever it is, and whether you decide to use behavioral ecology, interconnected macro math, or licking your finger, you have to decide on some type of signaling process to answer the question.

Knowing where you are in an economic cycle matters as much as understanding where your predator is (the other side of the trade). That’s why I think Vaillant’s epic true story of a man-eating tiger in Siberia is so relevant to my market day.

“If you see that his ears are down, that’s not a good sign. Then you have to look at him in the eye with all the rage you can muster and the tiger will stop and back off.” (The Tiger, pg 248) When do you think the bulls will back off lifting your offers?

Back to the Global Macro Grind…

How are the bears going to stop the US stock market from going up? Since there’s a bull market in top-calling right now, are they going to talk it down? That sounds scary. But does that have any teeth?

“You know, the ears are her steering wheel. You can turn off her teeth with the ears” (The Tiger, pg 96).

Admittedly, that advice comes from a Russian who used to “bag” tigers alive. Reading through Vaillant’s account of encounters with these big cats, I wouldn’t take a stroll into the taiga and try that alone. Neither would I short SPY’s with the VIX signaling 10.

Process Review: there are 2 main parts to how I make risk managed decisions in markets:

1. Risk Management Signals

2. Research Views

The Research and Risk Signals aren’t always aligned, but when they are, I move. Instead of the ridiculous “risk on, wax off” thing the sell-side implemented into Old Wall vernacular, let’s think of the market’s main risk (beta) as either having its Ears Up/Down.

Only 1 of those 6 Global Equity markets has its Ears Down. That 1 of 6 is not like the others because the Bovespa is a heavily weighted commodity stock market. This is why not everyone agrees with the fulcrum point of our Research View; not everyone gets paid by a Strong Dollar, Down Commodities. Know how people get paid, and you’ll know their confirmation biases.

Ears Down in Oil? Yep. And guess what’s driving that? #StrongDollar. While the immediate-term TRADE correlation between the SP500 and USD is currently POSITIVE (+0.84), for Brent Oil vs USD it’s NEGATIVE (-0.88). That’s another way to think about signaling without losing yourself in a Ph.D dissertation about causality.

Like a charging bull, bear, or tiger, the Correlation Risk happens fast. And unlike these non-domesticated animals, these mathematical monsters run fast, both ways. So keep those eyes and ears open!

Fear's Furnace

“Paris is now become a furnace of politics.”

-Thomas Jefferson

In the beginning, Thomas Jefferson fell in love with France. Eventually, he started falling out of love with some of her socialized parts. The aforementioned quote came from a letter he wrote to a friend in 1788 and went on to add that “all the world is run politically mad. Men, women, children talk of nothing else.” (Thomas Jefferson: The Art of Power, page 215)

Only 225 years later, free-market capitalists living in Paris probably still feel the same. Jefferson’s timing was, as usual, prescient. On July 14, 1789, The People stormed the Bastille Saint Aintone and the French Revolution went full throttle. All the while, George Washington was officially named the 1st President of the United States.

Imagine Americans were paralyzed by France’s politics then inasmuch as our global crisis-seeking media is now? That’s no way to live. There’s always a crisis somewhere in this world. There’s a crisis developing for those calling for a US crisis too.

Back to the Global Macro Grind…

Put another way, there is a crisis in the crisis. And, no, I am not saying that you shouldn’t be shorting countries whose economies have been socialized and compromised by modern Marxist regimes. If you are bearish on Italy, just short Italy.

Quantitatively speaking, Fear’s Furnace appears to be alive and well in Europe. Consider the following signals:

The Euro remains in a Bearish Formation (Bearish across all 3 of our core durations: TRADE, TREND, and TAIL)

Germany’s DAX just broke its immediate-term TRADE line of 7865 support (this week); TREND support = 7695

Italy’s MIB Index (-6% YTD) has been bearish TRADE and TREND for over a month now (Italian CDS now > 300 too)

So that’s bad – for them. But is everything that’s bad for them bad for you? Hopefully you aren’t reading this letter from Milan. But if you are, A) I hope it’s from vacation and B) that great cup of coffee you are drinking is going to get more expensive before you finish it.

In Euros, that is.

When your currency starts to get torched by politicians, you probably should start freaking out. If people really start freaking-out about Europe, what they are going to do with their fiat moneys next is more of what they are already doing – buying American:

European investors will buy US Dollars

European investors will buy US Stocks

European investors will buy US Treasuries

And while the last part of that is something I probably need to risk manage more aggressively now (the fund flow bid to US Treasuries), the first two parts of that (#StrongDollar, Strong US Equities) is more of what we continue to like anyway.

The reason why this is confusing consensus is that for the last 3 years, this is not the way that the Global Macro market worked. To review: 2010-2012 was the US Dollar Debauchery period of The Ben Bernank (i.e. the period where the entire capital market world learned to just front-run the poor guy’s Policies to Inflate).

Today, the marginal debaucherer of currency is Japan – and the to-be Bernanked (cutting rates to zero) zone is Europe. That, in turn, puts further downward pressure on Euros and Yens relative to Dollars – and puts purchasing power in the back pockets of Americans.

#cool

Or non, mes amis? Not so cool for those using the old correlation playbook of 2010-2012 either:

Dollar Up = Stocks and Commodities Down, globally

Dollar Down = Stocks and Commodities Up, globally

That’s when the game was less hard. Remember, “get the Dollar right and you’ll get a lot of other things right”? That’s still right, but in a completely different way:

Dollar Up = US and Asian Stocks Up

Dollar Up = Brazilian, Russian, and Emerging Market Stocks Down

Dollar Down = Commodities and Basic Materials Stocks Up

I know. Up, Down – all around. This is enough to make a man mad. Just be thankful you aren’t trying to trade S&P futures on what some French dude down on the Eastern edge of Paris was whispering to the Old Media’s twitterati , circa 1789.

HOUSING - BUBBLE CHARTS

Takeaway:With so much data flow on housing sometimes it's tough to keep track of it all. We think this image tells the story well.

Keeping It To 1000 Words ...

We like the chart below a lot. It tells the current story of housing succinctly in a way that everyone can easily understand. The x-axis shows inventory of homes for sale in millions of units monthly back to 2001. The y-axis is the pending home sales index reading. The bubble size shows the next twelve months home price change based on those levels of supply and demand. Not surprisingly, high demand coupled with low inventory produces big blue bubbles (strong home price appreciation), while the opposite produces big white bubbles (strong home price depreciation).

The obvious takeaway is that we're currently in a very favorable dynamic for prices, as shown in the orange circle. The orange circle shows current inventory and volume, but for bubble size, we've used LTM (as opposed to NTM) price change, which was +9.7% through February 2013 according to Corelogic. Note that the orange bubble is smaller than most of the other bubbles in the same area, suggesting price appreciation may accelerate from here.

Another takeaway is the inverse relationship between supply and demand. Inventories are negatively correlated with demand, which might seem at odds with recent commentary in the market about how low inventories are holding back transaction volume growth. Consider the range of volume that has accompanied the current level of supply historically. It's produced a volume range on the pending home sales index of 96 to 131. Currently we're near the low end of the range at 105. In other words, we've seen sales activity levels as much as 25% higher than they are today based on the same level of inventory, so we don't buy the NAR argument that it's inventory holding back volume. That said, there are likely other factors such as more stringent underwriting, which we consider a good thing.

Joshua Steiner, CFA

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